Sentiment can be described as simply as the mood of the market, mainly fear and greed. Sentiment should be the primary concern for short-term traders. It can last an hour, a session, a day or weeks depending on what is causing it and how much importance the market gives it. Thus, you have to identify the reasons why the market behaves in a certain way.
You will also see sometimes the market focusing on something and moving accordingly but then all of a sudden something else happens and the previous concern is completely forgotten. You should also take note of which session is driving the sentiment, because if you get some risk off in the European session due to some negative piece of news, it doesn’t mean it will be taken as equally negative in the North American session.
This may be due to further reports calming down the waters or just not in line with the prevailing theme, so it may be actually traded in the opposite direction in the new session with traders taking advantage of better prices to enter at.
That’s why it’s vital that you keep yourself updated on the latest developments because sentiment can go against the big picture fundamentals and if you are trying to enter in line with the fundamentals but against the current sentiment, you may find yourself in trouble with prices that keep going against you. It’s better to align sentiment with big picture fundamentals for the best results.
The two most common types of sentiment are risk-on and risk-off. Risk-on is when the market doesn’t see risks and you will often see common risk assets rally, such as equities, the commodity currencies and so on, basically assets that give high yields or returns for the money. Risk-off, on the other hand, is when the market does see risks and goes for more safe assets, like bonds, safe-haven currencies and so on.
In the currencies space the most famous safe-haven currencies are USD, JPY and CHF. The USD is the world reserve currency and the most liquid one.
The CHF is backed by a neutral country with a stable economy and low debt level. The CHF is so attractive during risk-off flows that the SNB is known to constantly intervening to weaken its currency because a high value could hurt Swiss exporters and thus cause deflation in the economy.
The JPY is the most popular safe-haven currency and it’s generally the one appreciating the most during risk-off flows. Japan has a stable political system, a liquid currency but its debt level is one of the highest in the world.
This should deter investors from placing their money into such economy, but Japan is also one of the largest creditors, owning foreign assets that are comparable to its debt. Another interesting fact is that all of Japan’s debt is held internally by its own citizens, so the risks of default are highly unlikely. JPY also appreciates because in risky times the carry trades get unwound with the JPY as the funding currency being bought back.
This article was written by Giuseppe Dellamotta.